Indian Currency and Finance

by John Maynard Keynes

While, therefore, it is to a certain extent within the power of Government (though not at present according to their usual practice) to urge a certain number of rupees into circulation more rapidly than is necessary, they cannot permanently increase the circulation without depreciating its gold value, that is, they cannot permanently increase the circulation beyond what it would otherwise be and at the same time maintain the rupee at 1s. 4d. It may be added that a release of rupees from any other reserve, or even a temporary increase in the amount of capital funds annually raised by Government abroad for use in India, would have a similar effect to the release of rupees from the Gold Standard Reserve. But, however all this might be, at present the Government of India do not, in fact, exert such discretionary powers as they possess for affecting, even temporarily, the volume of circulation.

9. I have said that the cost of sending gold to India does not generally exceed ⅛d. per rupee. The Secretary of State has, therefore, a standing notification (since January 1904) that he will sell bills at 1s. 4⅛d. Up to January 1900 he undertook to sell telegraphic transfers at 1s. 4⁵/₃₂d. without limit of quantity, and since that time he has usually been willing to do so.[54] The cost of sending gold to India depends, however, on complex causes, varying considerably from time to time, and is often a good deal less than ⅛d. It is not easy, therefore, for the Secretary of State to know at exactly what price gold will become a serious competitor of bills as a means of remittance; and not infrequently Council Bills are, unintentionally, at a price which makes it cheaper to send gold. It will be interesting to consider briefly the kinds of causes which influence the gold import point.[55]

10. The expense of remitting gold from one country to another is made up of insurance, freight, and loss of interest. Even the first item is sometimes capable of variation. For example, after the recent robbery of sovereigns in transit from London to Alexandria, the ordinary rate quoted on gold, consigned by the route (Bremen and Trieste) by which the stolen gold had been sent, was doubled, rising from 1s. 3d. to 2s. 6d. per cent. Again, on one recent occasion, it was stated that more gold would have been shipped if it had not been for the fact that the mail–boat was already carrying a million and a half sterling in gold and silver, the underwriters requiring a higher premium than usual if they were to insure a larger sum than this on a single voyage. But if it is a matter of shipping sovereigns from England the variations in the cost of insurance and freight are relatively small. The main part of variation in the gold point arises either out of the possibility of getting sovereigns from other sources, or from variations in the rate of interest.

These other sources are either sovereigns in transit from Australia or sovereigns ready for export from Egypt. As India lies between Australia and England, it is naturally cheaper (mainly on account of the smaller loss of interest) to send sovereigns from Australia to India than from Australia to England. Let us suppose that the state of the Australian exchanges is such that it pays to remit sovereigns from Australia to London anyhow, and assume, for the sake of simplicity (and without, in fact, any substantial sacrifice of truth), that the cost of freight and insurance from Australia to London is the same as from Australia to India. Now if, when the Australian sovereigns are off India, the bank which is remitting them can receive cash in London against their delivery in India, it will get its money at least a fortnight sooner, and will probably accept, therefore, about 1s. 3³¹/₃₂d. in London for 1s. 4d. delivered in India (¹/₃₂d. being the interest on 1s. 4d. for a fortnight at 5 per cent per annum). Gold bought in this way for immediate delivery in India is as good as a telegraphic transfer, i.e., is worth ¹/₃₂d. per rupee more than Council Bills. If, therefore, Council Bills are at a price in excess of 1s. 3¹⁵/₁₆d., gold about to be shipped from Australia competes with them as a means of remittance to India. Normally, of course, an Australian bank is able to get more than 1s. 3¹⁵/₁₆d. for gold delivered in India. I mean only that the Secretary of State cannot hope to undercut Australian gold, when it is available for export in large quantities, unless he is prepared to put down his price for Council Bills to this level. If, in these circumstances, he wants the gold in England rather than in India, his cheapest course, therefore, is to buy the gold in transit himself for delivery in England, selling for it telegraphic transfers at a suitable rate.[56] This was done on a large scale in 1905–6 and 1906–7.

Surplus gold from Egypt is not capable of undercutting Council Bills so seriously as surplus gold from Australia; for in this case it is Egypt which lies between. If we assume, for the sake of precise illustration,[57] that the cost of sending gold from Egypt to London is nearly the same as that of sending it from Egypt to India, an Egyptian bank, about to ship sovereigns in any case, will take any price in excess of 1s. 4d.[58] paid in London for the delivery in India of the value in gold of a rupee. This is the extreme case. If Council Bills are at a higher rate than 1s. 4d., say at 1s. 4¹/₁₆d., the Alexandrian exchanges may be at a level which makes it profitable to ship gold from Egypt to India for payment in London, when it is not profitable to ship gold from Egypt to London. If we still make the above illustrative (but not exactly accurate) assumption, when Council Bills are at about 1s. 4–¹/₁₆d. and the Alexandrian exchange on London below par, Egyptian gold competes with Councils as a means of remittance to India. Of course the supply of remittance from this source is usually somewhat limited; when some Egyptian gold has flowed away to India under the influence of the above conditions, this is likely to have the effect of strengthening the Alexandrian exchange, and therefore, by modifying the conditions, of making the continuance of a flow less likely. The Egyptian gold is of great practical importance, because the busy season in Egypt comes rather earlier than the busy season in India, so that in the winter months the gold which has served the purpose of moving the crops in Egypt can be sent on to be changed into rupees which are to serve the same purpose in India. Of the gold, therefore, which flows from London to Egypt every autumn, very little finds its way back again to London; what is not kept by the cultivators in Egypt travels on in due course to India. The precise moment at which this movement takes place and its extent depend, as we have seen above, on the rate at which Council Bills are being sold in London, and also upon whether the Egyptian cotton crop is dealt with late or early. But when towards the end of their busy season the Egyptian banks find themselves with more gold than they need, Council Bills must be sold at a relatively low rate if the flow of this gold to India is to be prevented. The dealings between the Egyptian and the Indian banks must thus present very delicate problems of arbitrage.

It is probably within the power of the Secretary of State, if he wishes, to regulate the flow of gold direct from London to Bombay by means of the sales of Council Bills. But when gold is available in Australia or Egypt, the matter is not susceptible of such easy control.

The remaining element which determines the cost of remittance—variation in the market rate of interest—has been dealt with already, ¹/₃₂d. represents the interest on 1s. 4d. for a fortnight at 5 per cent per annum. It is easy to calculate how the gold export point is affected by fluctuations in the market rate of discount in India on either side of 5 per cent.

11. So far we have been dealing with the upper limit of exchange and with the results of a heavy demand for Council Bills. The effects at the lower limit differ in this important respect, that the Government are under no legal obligation to prevent the depreciation of the rupee, and have not undertaken to give sovereigns for rupees in the way that they have undertaken to give rupees for sovereigns. There is nothing in law, therefore, to prevent exchange from falling indefinitely. There has been no change in law in this respect since 1895, when exchange actually did fall below 1s. 1d. The Government has, however, practically pledged its word to do all in its power to prevent the depreciation of the gold value of the rupee and to prevent exchange from falling below the lower limit of 1s. 3²⁹/₃₂d. The business community would rightly regard it as a breach of faith if the Government were to permit exchange to fall below this rate, unless all reasonable resources had been exhausted.

12. We now see how intimately the management of Council Bills and of Government remittance is bound up with the Gold–Exchange Standard. The disadvantages from the point of view of regulating a Gold–Exchange Standard, which arise out of there being no Government bank, are partly compensated by the Secretary of State’s being the largest dealer in foreign exchange. By regulating the amount of bills he offers for tender, he is able to regulate to a great extent the level of exchange. When exchange is falling below par he can support it by greatly restricting his offers; and if he cannot get at least 1s. 3²⁹/₃₂d. for his bills, he withdraws from the market. In the meantime, of course, he has payments to make in England, while on the other hand rupees accumulate in India, as the revenue flows in and no Council Bills are presented for payment. If the cash balances in London are not sufficient to stand the drain on them, gold at the Bank of England may be “un–earmarked” and placed to the Secretary of State’s current account, rupees in India being transferred at the same time from the Government balances to the silver portion of the Paper Currency Reserve—the reverse process from that which has been described already as the result of exceptionally large sales of Council Bills.

If the Secretary of State’s withdrawal from the market and the consequent scarcity of bills on India is insufficient to support exchange at 1s. 3²⁹/₃₂d., more drastic measures are necessary. The method adopted on the last occasion of this kind was the offer by the Government of India in Calcutta of sterling bills on London at the rate of 1s. 3²⁹/₃₂d., these bills being cashed in London out of the Gold Standard Reserve.